IRA investing: All at once or in installments?

(Money Magazine) -- If I can afford to put the maximum $5,000 into my Roth IRA at the start of the year, should I do it? Or would I be better off investing the $5,000 in monthly or quarterly installments? -- John Y., Los Angeles, Calif.

The short answer: If you have the money now, invest it now (and, if you're 50 or older and have an extra $1,000 for a catch-up contribution, throw that in too). If you don't have enough to make the maximum contribution, invest as much as you can now, and put in the rest as you get it.

That goes for any other money you plan to invest as well, whether it's in a tax-advantaged or taxable account. Invest it when you have it. As I'll explain in a bit, the real issue is how you invest it.

I realize from past experience that by advising you to invest this way I will incur the righteous wrath of the legions of investors and advisers who swear by dollar-cost averaging, or the practice of investing a lump-sum at regular intervals (usually monthly over the course of a year) rather than taking the plunge.

Advocates of this practice claim that it reduces risk and provides a way for anxious investors who might otherwise be too fearful to invest in stocks, bonds or other securities to get into the financial markets.

Even if that claim is correct, however, dollar-cost averaging is still an inefficient and (if you really think about it) illogical way to invest. But before all you dollar-cost zealots out there start to pillory me, I ask that you hold your fire at least until I explain why I recommend the "invest it if you got it" approach.

Actually, let me start by first disposing of the usual rationale that's trotted out to explain the superiority of investing all at once. The typical argument for investing cash immediately instead of spreading it out over time goes something like this: Stock and bond market values tend to go up more often than down over the course of a year.

Stocks and bonds are also more likely to outperform savings accounts and money-market funds, which is where you would usually keep a lump sum as it's being parceled out each month into stock or bond funds.

So, the reasoning goes, it makes more sense to have your money working for you as soon as possible in the asset that's likely to earn a higher return for the year than to put it in the asset that's likely to get a lower return and gradually move it to the asset with the better return prospects.

And people who make this case have a point. Stocks outperformed Treasury bills (a decent proxy for cash investments such as savings accounts and money funds) in 55 of the last 85 calendar years, while intermediate-term bonds beat T-bills 53 out of 85 times.

That suggests you're better off immediately investing in stocks or bonds or a combination of stocks and bonds than starting in cash and dollar-cost averaging out. (I say suggests because it's possible that stocks or bonds might outperform cash for the year but do so after lagging earlier in the year, in which case you might have had a higher return starting the year in cash.)

But I find this oft-cited rationale for investing a lump sum all at once vs. piecemeal underwhelming. Why? Because it looks only at return. And if you're going to be a truly prudent investor, you've also got to consider the risk you're willing to take when you invest.

The most sensible way to incorporate both risk and return into your investing is to start with an asset allocation strategy that makes sense given your tolerance for risk and your financial goals.

So, for example, if you're young and are willing to endure ups and downs in the value of your investments for a shot at higher returns because you have plenty of time to recover from setbacks, then you might invest, say, 80% of your money in stocks and 20% in bonds.

Rather, my point is that if you're investing in a serious and disciplined way, you shouldn't just be throwing money into investments willy-nilly. You should have a target asset allocation for your portfolio.

For argument's sake, let's assume that you've decided that an 80% stocks-20% bonds allocation is right for your Roth IRA. If that's the case and you've got $5,000 to invest, then you would want that $5,000 investment to reflect the allocation you've chosen.

So you would put $4,000 (80%) into stocks and $1,000 (20%) into bonds, and do so all at once as soon as you have the five thousand bucks. The alternative is to dollar-cost average.

In which case, you would start with the $5,000 in a savings account or money fund and then move $416.67 ($5,000 divided by 12) into stocks and bonds each month. But would this make sense? Not if you really believe that an 80% stocks-20% bonds portfolio was right for you.

After all, by dollar-cost-averaging your portfolio would start out 100% in cash, far more conservative than the 80%-20% mix you choose. Even after six months of investing you would still have half your five grand in cash and the other half split 80-20 among stocks and bonds.

Setting aside the effect of any returns over that six months might have on your portfolio mix, that would give you a portfolio with $5,000, or 50%, in cash; $2,000, or 40%, in stocks; and $500, or 10% in bonds. So you would still be invested much more conservatively than your target.

In fact, by parceling out your $5,000 over the course of a year, it would take you the full 12 months to get to the asset allocation you wanted in the first place. In short, by dollar-cost-averaging rather than immediately investing the money in accordance with your target asset allocation, you would be at a too-conservative allocation for 11 months. You are effectively undermining your investing strategy.

Indeed, what you're actually doing by starting out in cash and dollar-cost-averaging into stocks and bonds is going through a series of overly conservative allocations each month until you arrive at the one you want.

At this point, dollar-cost-averaging fans usually raise the following objection: Yes, but if I'd done what you suggest at the height of the market in (pick one: 1973, 1987, 2000, 2007) I'd have done a lot worse than if I had started in cash and dollar-cost averaged in over a year.

To which my answer is, sure, if the financial markets fall, then investing gradually and having more of your money in cash for a longer time will likely generate a higher return.

Of course, the opposite is true too: in years when stocks and bonds outperform cash, then getting more of your money to work faster in stocks and bonds will generate the higher return. Which brings us to the crux of the matter: You don't know in advance what returns various assets will deliver.

If you did, you wouldn't need to dollar-cost-average or allocate assets. You would move your money into an asset just as it's about to take off, then pull it from that asset just as it's peaking and move into another one about to surge.

But since that's not realistic, investors must find a way to get a piece of the gains the financial markets can deliver, while managing risk. I think deciding on a mix of assets that has a reasonable shot at providing an acceptable return with an acceptable level of risk is the best and most systematic way to handle the inherent uncertainty in investing.

Otherwise, investing is a guessing game. And if you do buy into the concept of asset allocation, then what's the point of undermining the allocation you set? If you would like to see a more technical explanation of why dollar-cost averaging is inferior to investing all at once in accordance with your asset allocation, check out this chapter from York University finance professor Moshe Milevsky's book, Wealth Logic.

The bottom line, though, is this: If you have the $5,000 -- or whatever amount you want to invest -- in hand, then invest it now in a way that reflects your asset allocation.

That said, if taking the plunge makes you so nervous that you may end up procrastinating or not investing the money at all, then by all means dollar-cost-average in. Doing that is certainly better than just keeping your money in cash or under your mattress.

But don't fool yourself. For all the hooh-ha one hears about the glories of dollar-cost-averaging, essentially it is nothing more than a form of asset allocation, except it's one that's inefficient and imprecise.